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Plans to stop financial advisers 'double-dipping'

Relationships between investment managers, advisers and platforms leave you open to being given conflicted advice and paying fees that do not match the services you enjoy.

They have also left the new financial services regulator scratching its head over how to define and regulate investment managers and investment advisers, to determine if they are independent and if they are charging for a service that adds value to your investment.

A dense Retail Distribution Review discussion document released recently by the Financial Sector Conduct Authority (formerly the Financial Services Board) gives an eye-glazing summary of the issues that bedevil the investment industry.

In its first set of proposals, released in 2014, the FSB proposed banning financial advisers from managing so-called white-label unit trust funds. Also known as "third party" funds, these are funds whose managers do not have their own collective investment scheme licences and make use of another unit trust fund company's licence. The idea was to allow start-up fund managers who did not yet have the resources to set up on their own licence, with their own administration, to rent licences from established managers.

But financial advisers took to renting out licences to set up white-label fund of funds - funds that invest in other unit trust funds. Advisers essentially set up multi-managed funds to invest across asset classes in a mix designed to match their investors' risk needs and tolerance; for example, low-risk, low-return conservative funds or higher risk, higher return aggressive funds.

But these funds, known as broker funds, let advisers collect an advice fee to steer their clients into funds they manage and for which they charge an investment fee. This practice is known as double-dipping.

The managers who rent their licences have full legal responsibility for the third-party funds, may only allow qualified managers with the relevant Financial Advisory and Intermediary Services Act licence to manage the funds - and, since 2011, have been obliged to co-brand white-label funds with their name and that of the broker or new manager managing the fund.

They are also obliged to enter into agreements with the broker or fund manager setting out any conflicts of interest and how these will be managed.

But this didn't allay the FSB's concerns about abuse. Its proposed ban on brokers setting up white-label funds elicited much response, uncovering for the FSCA a host of other practices from which it thinks we need to be protected.

Many South African financial advisers now delegate the selection and management of your investments to discretionary investment managers (or discretionary fund managers). These managers run what are known as model portfolios on investment platforms for advisers' clients.

As an investor, you pay these managers a fee, typically offset by a discounted fee from the asset manager, who gets a bulked investment from the discretionary investment manager. But it is difficult to measure the value these discretionary managers add for that fee, or how qualified they are.

And what happens if the investment adviser and discretionary fund manager are the same entity or in the same group? Vertical integration is the buzz word for investment advisers in a financial services company who advise you to invest in a model portfolio put together by a discretionary fund manager in the same group, using underlying unit trust funds from the group's asset manager and accessing the funds on the group's investment platform.

It is difficult to measure the value these discretionary managers add for that fee

While this may offer value for money if fees are discounted, the cumulative fees on some portfolios have exceeded 4% a year.

Lance Solms, the head of low-cost exchange-traded fund platform Itransact, says with fees of 4% a year, returns of 15% a year and inflation of 6% on a 20-year retirement saving portfolio, you will lose a staggering 50% of the returns you earn.

In the FSCA document are proposals investors should welcome and some you should use to guide you through the tangled webs until the FSCA puts the proposals in place, which could be many months hence.

One proposal suggests more rigorous FAIS licence requirements for investment managers who choose shares, bonds and other securities for your unit trust funds, and lesser requirements for model portfolio providers.

Another says a financial adviser who obtained what the FSCA identifies as a mandate of convenience - which allows him or her to regularly rebalance your portfolio so it stays within an asset allocation you and your adviser have agreed is suitable for you - should probably not be allowed to charge for this service.

The discussion document suggests that if the entity managing a white-label fund also gives advice on your investments, that cannot be labelled independent advice.

The FSCA also wants unit trust companies, investment managers and model portfolio providers to conduct due diligence checks - more than just checking on the relevant licences - on the managers and underlying funds they select.

Advisers who recommend investment managers or model portfolio providers will also have to conduct due diligence inquiries on these entities.

The FSCA also wants them to check out investment platforms before listing their funds and model portfolios on them. In turn, investment platforms may be required to conduct due diligence on any unit trust company, investment manager or model portfolio it plans to list on its platform.

Fund platforms are likely to say this is impractical as there are more than 1000 funds and a similar number of model portfolios listed on local platforms.

The FSCA is now proposing that the Association for Savings and Investment South Africa extend its new cost measure, the effective annual cost, to ensure you understand the amount you will pay and the impact of all layers of fees when you use model portfolios or white-label funds on investment platforms.

It is also seeking input on how to measure whether the fees you pay match the services you get, and has suggestions on how to ensure you don't pay twice - for example, banning investment managers or model portfolio providers from holding a licence to give advice, or charging for both advice and investment management.

It also wants robo-advice fees justified and lower fees for investors who don't want advice.

These measures may still be proposals, but there is no harm in asking for this level of disclosure now.